Execution Risk Management
Trade Execution (TE) professionals play a crucial role in realizing the value created by the commercial team. Beyond managing the contract rights and obligations between parties, they must also navigate broader trading environments and associated risks when making execution decisions.
Trade Execution: A Key Player in Managing Market Risk During Contract Performance
In any trading organization, market risk—the risk that price volatility will affect contract performance—is a critical concern. While commercial teams are typically responsible for managing these risks, the Trade Execution (TE) team plays a key role in mitigating the effects of adverse price movements during contract performance. TE professionals work closely with commercial teams to ensure that market conditions are factored into decision-making during contract execution, helping to ensure performance.
The Impact of Market Risk on Contract Execution
Market price volatility during contract execution can subtly influence counterpart behavior. If prices move against the contract counterparty—whether in the global or local market—they may seek to leverage minor performance issues (perceived or otherwise) to push for discounts or, in extreme cases, claim non-performance. Conversely, when the market moves in favor of the counterparty, performance risks tend to decrease, though this doesn’t lessen the TE team’s need to remain vigilant in overseeing execution. There may also be contract clauses for pricing deadlines, margin calls, deposits, or guarantees—tools used by commercial teams to manage and mitigate risks associated with price volatility. It is up to the TE team to ensure that any obligations are met.
TE 101: Managing Market Risk
One of the first lessons for TE or commercial trainees upon joining a trading organization is understanding market risk in contract and execution decisions.
A fundamental principle, for example, is to plan sales at the highest price relative to purchases at the lowest. This is particularly effective for back-to-back "paper" trades, helping to minimize exposure.
However, market risk goes beyond planning. It often interacts with counterparty risk. For example, in soft commodities like sugar, market volatility during long transit times can affect buyer performance. Price fluctuations in global and destination markets can stress traders, buyers, and receivers, especially when dealing with priced contracts in the process of being shipped. Being aware of general market conditions is essential to securing performance.
TE teams don’t work in isolation. When market prices fluctuate, the trading team must signal these changes to the TE team and engage in discussions about trade lanes and counterparties requiring extra attention, enabling proactive risk management.
Market risk also extends to managing goods in warehouses or collateralized stock. Supply chain disruptions can lead to product shortages, causing price spikes. In such cases, additional measures may be required to secure and report on stock levels.
Managing contract execution risk is not just about adhering to contractual obligations—it requires a deeper understanding of the broader market context and proactive collaboration across teams. By staying closely aligned with commercial teams, leveraging flexibility in execution, and maintaining strong relationships with counterparties, logistics, and warehousing providers, TE professionals can anticipate and seek to mitigate the risks associated with price volatility.
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